Why is a Grexit now likely?

Greece owes the IMF 1.6 billion euro that it doesn’t have but is supposed to pay tomorrow. Unless the ECB lends it to the Greeks, effectively converting the IMF debt into an ECB debt, Greece is bankrupt tomorrow. In months to come, much bigger debt repayments are scheduled to the ECB-IMF in tranches of 4 billion, and Greece won’t have that money either as its economy is still contracting.

Greece didn’t have the money to pay off the previous debts in the last 5 years either though, and that just lead to more debts in return for symbolic reforms that weren’t implemented.

Why not muddle then then and let the Northern European politicians present a pretend-reform package to their population as a victory? And why would bankruptcy force a Grexit, given that there is no official mechanism to force any country out of the Euro, once it is in?

What I think is forcing the Grexit now is the combination of the referendum on the symbolic reforms, together with the bank-run on the Greek banks that has this morning lead to capital controls.

The referendum is called for this Sunday, one or two days before the banks supposedly re-open for open business. The idea is that Greeks vote on whether to accept the current set of symbolic reforms, which would entail cuts to pensions and loss of employment of many civil servants. The government will campaign against them, and the majority of the Greek parliamentarians are with the government, successfully whipping the country into a ‘no austerity’ mood. There is hence no way that the Greek population would vote ‘yes’. And even if they did, the Greek government then would not implement reforms as its own backers would constitute the ‘no’ vote.

But the referendum also makes it impossible to agree on something symbolic beforehand: it binds the hands of the Greek politicians who called for it (almost surely so they wouldn’t be blamed for the coming Grexit). This means nothing can be offered to them that would prevent bankruptcy tomorrow.

Previous symbolic reform packages were not implemented, partly because the Greek governments didn’t want to implement them and partly because they couldn’t even if they wanted to. Tax collection, for instance, would take many years to clean up and, as a Greek economist told me half-jokingly recently, it is still normal to send Greek tax collectors home in an election year! But to the Northern Europeans, the Greek politicians at least pretended they were going to pay back the loans and reform. The referendum is now expressly fought on a platform of not even pretending either, taking away the much-needed fig-leaf that the Northern Europeans wanted.

Worst of all, the referendum is a slap in the face of the other politicians who were negotiating at this late hour with the Greek politicians on the terms of the next symbolic set of reforms. It is part of the rules of the game in Brussels that this was a real deadline that forced everyone to agree to some face-saving formula. The referendum has made this impossible: the Greek politicians won’t play by the European rule-book. No face saving, just Greek theatrics and grand-standing.

So the other European politicians have been sufficiently humiliated that they feel they need to be tough, an attitude you see most clearly in Christine Lagarde from the IMF who made it clear tomorrow’s deadline is not negotiable.

Hence the referendum will likely be followed by a continuation of the bank run by Greeks who calculate their country’s approaching bankruptcy, and this time there cannot be a bailout: the only bailout that is now possible within the Greek political system is one whereby the ECB lends money without symbolic reforms, an open loss for the Northern Europeans. That means there will be no bailout. In concrete terms, the Greek central bank will not be getting any more Euros to distribute amongst its banks. The Greek government wont be able to pay to its employees, welfare recipients, and other recipients of state money.

So the day after the referendum, neither the Greek central bank, nor the Greek government has money to prop up the Greek commercial banks nor pay its own workers. That is what will force the Grexit, I think, not the inability to pay back loans to non-Greeks: the slow bank-run, in which billions in deposits are withdrawn weekly from Greek banks, will force them into it.

If the Greek government does not introduce a new currency then it will have no means to prevent the bank-run and the Greek banks will run out of money and go bankrupt themselves. Without an intervention, that will wipe out all the savings in those banks and lead to a major disruption of the Greek financial sector and the Greek economy. Tax avoidance will go up as the visible money streams that go via the banks will stop and the remaining economy will go via invisible money streams that are harder to tax. Greek civil servants will not get paid, nor will welfare recipients get their payouts, meaning they will have no money either, forcing them to join the bank run to pay for groceries.

So the Greek government will face financial collapse in the days after the referendum. Capital controls will slow the collapse down, but the only thing it can do, really, is to take over the obligations of the commercial Greek banks, guarantee the deposits of the population, and pay its employees and welfare recipients with something else. That something else is a new currency, whether it starts life being called an I-Owe-You (IOU) or a Varoufakis-florint: it will have to be declared legal currency inside Greece so that one can make payments with it. Hence in order to save its own banks and thereby its depositors, Greece will have to Grexit.

Now, no-one can force Greece to give up the Euro, so Greece can in principle maintain a dual currency system for a long time, having both the Euro and the new currency as legal tender. This is not abnormal, as Hong Kong airport has shown you can run a 3-currency system indefinitely: you can pay there with Honk-Kong dollars, Euros, and US dollars. Yet, if the state sector runs on fast devaluing drachmas and the rest on stable Euros then the Greeks will be incurring a lot of transaction costs.

It will not really matter though whether Greece hangs on to two currencies or just the new one: with the re-introduction of a separate legal currency, Greece will have effectively left the Eurozone and become like Macedonia and Bulgaria, where you can also pay in lots of places with Euros but that are no longer official members of the Eurozone. It will be sufficient excuse for the ECB to declare that Greece has exited from the Eurozone.

I wouldn’t be surprised if stacks of the new currency are already in Greece, ready to replace the Euro as the official currency, with contingency scenarios now being taken off the rack in the main financial European institutions (EIB, ECB, EU-C) and in the individual countries. This means a Grexit is also a physical possibility now whilst it probably could not have been done 5 years ago.

Is there a way to prevent the coming Grexit? Normally, I expect the political system in the EU to come up with a watery compromise at the last minute, and you hear plenty of rumbling to that effect. The Greeks politicians have however, I think, made this impossible with a referendum that takes away the ability for compromises to be offered and accepted. Time will tell though: the ability of the EU to muddle through is astounding.

Will a Grexit be good for Greece? In the medium-run, I do think so as the state-related sector takes a much needed price-correction vis-a-vis the exporting sector. In the short run though, pain is coming, particularly for the old and infirm in Greece dependent on the state. And the recovery will be hampered by the fact that the Greek economy is tied to the rest of Europe, whom the Greeks have just had a falling-out with.

Author: paulfrijters

Professor of Wellbeing and Economics at the London School of Economics, Centre for Economic Performance

17 thoughts on “Why is a Grexit now likely?”

  1. Can you explain how having your pension cut below subsistence level constitutes a “symbolic” reform? (I leave aside the question of in what way this constitutes a “reform”.)


    1. Because I don’t think they would implement it. I encourage you to look at the history of tax reform there over the last 5 years. Or privatization.


      1. Given the way Lagarde et al., have insisted on this — explicitly demanding these instead of taxes on the rich — do you think the institutions would allow it to remain “symbolic”?


      2. Lagarde’s list of the 2000 top tax evaders in Greece has been roundly ignored by successive generations of Greek politicians, though the Greek journalist who wrote about them has been dragged to court a few times (see https://economics.com.au/?p=10076&). You can accuse Christine Lagarde of many things, but not that she hasn’t tried to hold the rich Greek elite to account.

        I would encourage you to look at what is actually happening inside Greece, and particularly who is running the show there. To my own dismay, many of the new politicians turn out to be old politicians who merely jumped political labels.

        On the whole though, I am not commenting on the morality of the situation, merely on what now seems to be afoot.


      3. Well, how did Greece manage to achieve a primary surplus then? Really, enough austerity has been undertaken to see GDP drop by 25% and unemployment rise by 25% and you think the reforms have been ‘symbolic’?

        Personally, I agree that some hard structural reforms had to be undertaken and a painful adjustment was unavoidable but there has been to much moralising going on.

        Private creditors were complicit in Greece ending up with unsustainable debt and should have been forced to take a haircut in 2010. Be that as it may, what should have happened during the recent negotiations is that the troika should have agreed to debt restructuring that would increase the value of the repayments they could expect from Greece and at least give Greece some hope of coming out of this nightmare in the next couple of years. That would have been the rational thing to do.


  2. You said: “I wouldn’t be surprised if stacks of the new currency are already in Greece.” Would this not be pretty difficult to keep secret?


    1. A couple of trucks in the basement of the Greek Central Bank, sent by the ECB yesterday? Or even earlier, if they were in some ECB-related office?

      You wouldn’t need many Greek officials to be in the know, though as soon as you start to unpack the stacks yuo have to have a media strategy in place.


  3. If Greece started printing Euros, which it can do. Even more compelling, if it engaged in a Rudd style stimulus package [electronic printing]. Northern Europe would have to create a new currency the NEURO and leave the EU


  4. Paul, You write like a good Northern European with little sympathy or understanding for the problems of the Southern Europeans who are stuck in a fixed exchange rate regime without a fiscal authority to help the poorer economies. Greece (like Spain) has a horrific rate of unemployment and poverty is increasing rapidly. If the ECB had supported the Greek economy at the outset the debt was a miniscule share of the European economies. I think Greece should have defaulted ages ago.


    1. your sympathies are clear, Raja!
      I am trying not to moralise in the above, just predict the coming chain of events. No shortage of blame, if you ask me. And indeed, I think nearly everyone would have been better off without the initial bailout.


  5. From the perspective of the Greeks, many economists now believe a default in 2010 would have been preferable. The 2010 and 2012 bailouts have not done much for Greece, except maybe enforce some fiscal discipline. But an early debt default would have achieved fiscal discipline anyway.

    However, the bailouts did permit time for the German, French and other northern European banks largely to exit their Greek debt positions. Consequently, the contagion risk associated with a Greek default is substantially reduced for the rest of the EU (and the world). Whether this “gift” to the northern European banks was a good thing or not is an extremely interesting question.
    There seem to be four major themes in discussions of that question:

    (1) how real was the contagion risk of not allowing time for the northern European banks to exit their Greek debt?

    (2) what is the morality of bailing out your own northern European banking system (and its shareholders) and then subsequently permitting the Greek system to collapse? Should the bailout of the northern European banks been done overtly in 2010 by the ECB buying their Greek debt? Would this have been politically possible? What about Spain and Portugal? To get a handle on this one needs to fully recall the global mindset in 2010 and 2012.

    (3) what responsibility does the ECB bear for the pre-crisis bank capital adequacy zero risk weighting all sovereign debt that induced banks to hold Greek debt? Should that zero risk weighting be interpreted to mean that the ECB was providing an implicit guarantee for Greek debt? and

    (4) what is the moral culpability of the various Greek governments for allowing themselves to get into this situation in the first place?


    1. Hi Casey,

      several good points here, many of which I have already posted on in the past.

      The socialisation of the bank debts (not just Northern European, btw) in 2010-2012 really brings up a lot of hard political economy questions as to whom the European elites have served.

      As to morality: there is plenty of egg on plenty of faces, going back to the early 00s. The decision by the politicians to waive the Maastricht criteria, not just for Greece, was really the one that set the debt boom juggernaut in action. The alternative then, as now, was to have a core group of EU country form a political and economic union, with the rest invited to join when ready.


  6. If Greece grexits and issues a new currency worth say half a Euro then every Greek business, bank or non-bank, that has significant liabilities in Euros will be bankrupted. This is not the same thing at all as a country with its own currency that defaults and devalues, a la Argentina. Every German, French, Italian, whatever, business that is owed by Euros by a Greek business will be suing in the European courts for years. The Greek banking system will have to be wiped and new banks created, presumably by the Greek Government, but it won’t be able to capitalise them.

    This is not a recipe for medium term recovery.


      1. absolutely, a crucial point and another example of what the Greek political economic system has decended into. The implicit new loan via the ELA now amounts to a staggering 89 billion Euros, much of it in the last year.

        Cast your eyes also on http://www.macropolis.gr/?i=portal.en.the-agora.2080 and just look at where the 250 billion euro loan that the Greek government was given in tranches over the last few years went to. French and German banks? Not at all. Yes, there was some debt maturing and interest rate repayment, but the degree to which that went to French and German banks appears paltry (follow the IMF links at the bottom). Rather, large chunks of the money was used to prop up the greek banks. Now, in other countries, those payments have to come from government revenue one way or another, so really you are talking about expenditures within Greece that are in effect an enormous stimulus package.

        The whole austerity line that many commentators push is bs from start to finish. The end of the credit boom lead to an inevitable recession, but the massive transfers to Greece seem to so far have mainly lead to ever more inventive ways of borrowing from the rest of the Eurozone.


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